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Summary

  • The relationship between SPY and my U.S. Economic Index continued its return to normalcy in May, as SPY and the USEI moved in the same direction.
  • SPY reached another record monthly closing high share price on an adjusted basis, advancing to $192.68 from $188.31, a gain of $4.37, or 2.32 percent.
  • And my USEI, primarily based on data provided by the Institute for Supply Management, climbed to 56.19 from 55.16, a hike of 1.02 points, or 1.86 percent.

It is an article of faith (and statistics) hereabouts that changes in the American equity market, as represented by the nonproprietary SPDR S&P 500 ETF (NYSEARCA:SPY), eventually mirror changes in the economy, as represented by the proprietary U.S. Economic Index. However, it is also an article of faith (and statistics) hereabouts that anomalies in this relationship developed because of the Federal Reserve's current quantitative-easing program, as indicated in "SPY, MDY And IJR At The Fed's QE3+ Market Top."

Therefore, I have been happy to observe the anomalies in the continuous feedback loop between the market and the economy begin to dissipate as the Fed's Age of QE3+ starts to come to a close, with its asset purchases on a monthly basis dropping to $45 billion in May from $85 billion in December, as dictated by the Federal Open Market Committee.

I built the USEI in an attempt to capture all U.S. economic activity in a single monthly figure I could employ in guiding my investing and trading. I constructed it primarily using Institute for Supply Management (ISM) manufacturing and nonmanufacturing numbers, as mentioned in the blog post that introduced the USEI at J.J.'s Risky Business. ISM released its latest manufacturing figures Monday and its latest nonmanufacturing figures Wednesday.

Figure 1: SPY And USEI Monthly Values, January 2008-September 2012

(click to enlarge)

Note: The SPY adjusted monthly closing-price scale is on the left, and the USEI monthly value scale is on the right.

Source: This J.J.'s Risky Business chart is based on proprietary analyses of ISM data and Yahoo Finance adjusted monthly closing-price information.

ISM has published the relevant manufacturing figures dating back to January 1948, but the nonprofit organization has published the relevant nonmanufacturing numbers dating back just to January 2008. Accordingly, the complete data set for the USEI encompasses only 77 months.

During its first 57 months (i.e., before the dawn of the Fed's Age of QE3+), the USEI acted primarily as a leading indicator and secondarily as a coincident indicator of SPY's upward and downward movements. I calculate the SPY-USEI correlation coefficient as 0.75 over this period (Figure 1).

Immediately before and immediately after the advent of the Age of QE3+, this same number quantified an observable positive correlation between the stock market and the economy that was not only stable but also strong, with the SPY-USEI coefficient calculated as 0.75 each of the six months from July to December in 2012.

Figure 2: SPY And USEI Monthly Values, October 2012-May 2014

(click to enlarge)

Note: The SPY adjusted monthly closing-price scale is on the left, and the USEI monthly value scale is on the right.

Source: This J.J.'s Risky Business chart is based on proprietary analyses of ISM data and Yahoo Finance adjusted monthly closing-price information.

During the past 20 months (i.e., after the dawn of the Fed's Age of QE3+), there was a breakdown in the SPY-USEI relationship, indicating a disruption in the continuous feedback loop between the equity market and the economy, a rupture first observable around January of last year.

I calculate the SPY-USEI correlation coefficient as -0.07 over this period (Figure 2). The comparable figures were -0.22 a month ago and -0.30 two months ago. Collectively, these numbers therefore suggest progress in the move toward normality and away from abnormality in the SPY-USEI relationship.

Similarly, the overall SPY-USEI correlation coefficient has been stable the past three months, following its plunge to 0.61 in March of this year from 0.75 in December 2012.

Figure 3: USEI Monthly Values, 2014 Versus 2010-2013 Mean

(click to enlarge)

Source: This J.J.'s Risky Business chart is based on proprietary analyses of ISM data.

The USEI was an overachiever to an insignificant degree in April and to a significant degree in May in the wake of its bad behavior in the first quarter when compared with the mean values compiled for the months between January and May during the first four years of the current expansion (Figure 3).

Figure 4: USEI Monthly Values, 2014 Versus 2010-2013 Median

(click to enlarge)

Source: This J.J.'s Risky Business chart is based on proprietary analyses of ISM data.

The USEI also was an overachiever to an insignificant degree in April and to a significant degree in May in the wake of its poor performance in the first quarter when compared with the median values compiled for the months between January and May during the first four years of the current expansion (Figure 4).

I believe the USEI's recent performance bodes well for SPY, at least in the short term. It appears one of the casualties of the Age of QE3+ is the USEI's status as a leading indicator for SPY. I calculate SPY-USEI correlation coefficient on five bases, not only apples to apples but also with offsets of between one and four months. When I crunched the numbers this week, four of the coefficients were 0.61 and one of them was 0.62. As a result, I now consider the USEI to be solely a coincident indicator for SPY. Alas.

Disclaimer: The opinions expressed herein by the author do not constitute an investment recommendation, and they are unsuitable for employment in the making of investment decisions. The opinions expressed herein address only certain aspects of potential investment in any securities and cannot substitute for comprehensive investment analysis. The opinions expressed herein are based on an incomplete set of information, illustrative in nature, and limited in scope. In addition, the opinions expressed herein reflect the author's best judgment as of the date of publication, and they are subject to change without notice.

Source: SPY And U.S. Economic Index Both Head Higher For Third Consecutive Month